The Dividend Cafe - 2017....Off With A Bang!

Episode Date: January 5, 2017

2017....Off With A Bang! by The Bahnsen Group

Hello, happy new year and welcome to this week's Dividend Cafe podcast. I hope and trust your holiday season was restful, joyful and memorable and that you are as enthusiastic for the new year as we are. It's felt like a short week this week because of the Monday holiday and all the re-entry work of Tuesday, but we're very much underway and markets have needed no time to kick in the new year, if you will. Suffice it to say, 2017 has started off better than 2016 did, but of course, 2016 turned out pretty good regardless, didn't it? The next week we're going to be presenting through the Dividend Cafe, our comprehensive look at 2017 and what we're seeing and doing and believing entering the new year, posting a kind of more comprehensive white paper to the website. We won't do a podcast of the whole thing because it's going to be much longer, but we certainly

would encourage you to look at DividendCafe.com next week for our 2017 Outlook white paper. In the meantime, there's some interesting nuggets this week, so let's get into it. Forgive me for this water I'm pouring on things, but if there's one thing we suspect would be volatility inducing in the weeks or months ahead, it's a failure of investors to appreciate the complexity and uncertainty and such that will go into implementation of President-elect Trump's economic agenda. Investors understandably celebrate the concept of tax reform, of deregulation, or repeal of certain expensive and unpopular laws, but it does not appear to us that there has

been sufficient appreciation of the fact that there is likely to be pushback, disagreement, horse trading, surprises, delays, and any number of things that cause markets to gyrate around as these things get uncovered. Would we dare trade around much of that? No. Heavens no. It is not something you can trade around these various kind of up and downs that are likely to come through the up and downedness of the legislative process. we have seen laid out will be bullish. Corporate tax reform, foreign profits repatriation, a repeal and replace of the Affordable Care Act, energy markets deregulation, etc. Yes, absolutely. We do see those things in a very eventually bullish context. Along the way, we find it a bit hard to believe that there will be no gyrations as these things end up being absorbed into the realities of federal politics. The best and worst of 2016.

The top performing sectors of 2016 were energy up 27%, telecom up 23%, and financials up 23%. The worst performing sectors were healthcare down a little over 2.5%. Consumer staples up about 5%. Consumer discretionary up about 6%. So even those two that were up 5% and up 6% in the consumer area, those were still two of the worst three sectors. Only health care was negative on the year. How healthy is housing or this week's sign of the apocalypse? Flipping, the practice of buying a home and then quickly selling it, presumably for a profit, reached its highest level since 2007 last year. $46 billion of flip transactions were done in 2016.

We will refrain from comment as to whether or not this should be viewed as a healthy sign, and will simply let history do the talking for us. It's not beta we dislike, it's that beta. Stable companies thought to be less volatile It's not beta we dislike, it's that beta. Stable companies thought to be less volatile have had periods of being quite en vogue, and this has led many to understandably say that it is now time for high beta to shine. High beta refers to a stock that has even more volatility than the S&P 500 itself. So a beta of 1.5 might be expected to have 50% more movement up or down than the market itself. And a beta of 0.5 might be thought to have half as much movement related to the market itself. We're totally agnostic as to whether or not an investor

We're totally agnostic as to whether or not an investor might want more beta in one particular season, meaning more market correlation, volatility, and maybe less in another. We have a permanent bias, not a cyclical one for lower beta, for the simple reason that we're looking to create an outcome within each client's respective appetite for up and down fluctuations, volatility. We make our decisions on the valuations and cash flow creation of individual companies, and when we have more beta than we might at a different season, it's purely incidental to the companies that we want to own. So to the extent that high beta does well this year, we think it's likely to be in financials, energy, and industrials, all areas we're invested in. But what we do not like now or ever is betting on companies that are very, very overvalued to become very, very, very,

very overvalued. Does that strategy work sometimes? Of course it does, but it will never be deployed at the Bonson Group as it violates our beliefs about managing risk and reward. Are muni bonds just mush now? The carnage in November that carried into December may cause some investors to feel that the safe money of their portfolio is anything but. Such is the life of an asset allocated investor. The protection we get from zigs and zags has the ironic effect of highlighting what is zagging even as other assets are zigging. Interestingly, most muni prices seem to have recovered from their December lows back to their December highs, but that is still quite a bit below pre-election November highs.

One thing we would like to remind bond investors of, when one owns a bond at a premium to par and they intend to hold it to maturity for whatever reason, a reduction in the amount of the premium along the way in market price is a completely immaterial and irrelevant factor. A bond at $110 that goes to $105 means nothing when we know its final destination is $100. The speed of that premium going away is interesting, but it's not economically material. The coupon the bond pays determines the attractiveness of the bond in the context of a total diversified bond portfolio. So price volatility affects statement value, but not a lot else. In the meantime, a 10-year bond yield between 2.25% and 2.6 percent is our expectation for the time being. With a yield going above that being likely pretty bullish for stocks but not for muni or treasury bonds

and a yield going below that that range likely meaning a rally in bonds but trouble in equities. We emphasize likely because no particular outcome is ever assured. My second bucket of water to throw out. In prior editions of Dividend Cafe, we expressed the view that markets were likely to be quite warm to President-elect Trump's selection in commerce, labor, energy, treasury, I would add EPA, and other such cabinet and senior type positions. However, as we wrote the day after the election, the trade leadership team was of particular concern to us as we simply were unclear as to how serious some of the more protectionist Trumpian rhetoric was relative to real life policy. If we are being honest, we have to say that the selection of Robert Lighthizer for U.S. trade representative and Peter Navarro, a UCI professor, by the way, University of California, Irvine here in our backyard, as head of National Trade Council, it represents the potential for market disruption. Both gentlemen represent the harder

line of economic protectionism, tariff threats, and seeing trade as a zero-sum game. And we believe that could be very problematic for markets. It's way too early to tell how these advisors and policymakers will actually craft actionable policy, but we cannot take our eye off the ball for anything that hammers at free trade and markets. Rising consumer prices, trade wars, and other such potential anti-growth consequences are a real danger. Dollar dilemma. We'll touch on this more in our white paper that we discussed earlier next week, but it goes without saying there's a lot on the line in terms of the U.S. dollar does in 2017. On one hand, it has advanced a stunning 25% against a basket of currencies since 2014, and it can be said to be overvalued

in a number of metrics. But on the other hand, plenty of fundamentals argue it has room to advance more, particularly if Fed policy shows greater tightening than expected and Europe and Japan ease more than expected. We would say a dollar retracement is probably a neutral event, may take away some earnings headwind for certain exporters. And a dollar advance would be selective, probably hurting some, helping others short term. But what do we do about it? We do nothing, for it's a totally unpredictable and unknowable event. The total impact of currency on a net basis is very low across our portfolios. When crazy was actually quite sane. Because of the tremendous headline volatility of 2016, China, Brexit, Trump, Fed, etc., and because last

January was so ugly and a few other spurts in markets were so heavily covered in the media, it's understandable that some investors may describe 2016 as a crazy year. But if we mean by crazy that there were elevated levels of volatility, that's patently false. It wasn't an abnormally low volatility year either, but it was a textbook year of normal. The annualized volatility level came in at 13%, and this puts a smack dab in the middle of all years going back to the Great Depression, the 47th percentile to be precise i'm gonna direct you to the dividendcafe.com website if you want to see a little more information a couple charts and things we've posted but we'll go ahead and leave it there for now um i'm still basking in the

glory and celebration of usc Rose Bowl victory on Monday night, a game that I attended and will never forget the rest of my life. Yes, it was just a game, but frankly, we're off to a great start with 2017. I can speak for me and my whole team when I say we couldn't be more excited for what lies ahead for the year. Reach out anytime. We love hearing from you. Thank you for listening to this week's Dividend Cafe.